What is the impact of inflation on wages, assets and debt?

Different spending patterns

Not everyone experiences inflation in the same way. Some households spend much of their income on groceries or housing costs, while others spend relatively more on clothes or holidays. But it is not just spending patterns that cause inflation to affect households differently. Wage increases also work out differently for some households than for others.

Effect of wage increase varies

Inflation in the Netherlands is not yet at the target level of 2%, but we are getting close. In 2022, things were very different: inflation peaked at 17.1%. High prices put a big dent in purchasing power that year. Products and services became more expensive, but wages did not rise along with them. Lower-income households struggled to pay the bills, partly because their fixed and necessary expenses became more expensive.

To compensate for weakened purchasing power, workers demanded higher wages. They were able to do so, supported by the tight labour market and productivity growth. Consequently, wages started to rise in 2022. By now, the average real wage has almost returned to its pre-inflation-peak level, and is expected to increase slightly further over the next year, according to DNB's projections. The real wage is the amount you can actually buy with your salary after taking into account price increases.

However, adjusting wages in line with inflation takes time. A DNB analysis shows that wages usually adjust fully to price increases, but this takes about five years on average. This means that households may temporarily have less purchasing power in the intervening years.

Wages rise, but not equally in all sectors

Average wages have increased since 2022, but that does not mean that the purchasing power of all households has improved equally. Wages rose relatively strongly in education, government and trade, but the financial services and cultural sectors actually lagged behind in collective wage increases. The government also increased the minimum wage. Benefits linked to the minimum wage such as welfare, state pensions and unemployment benefits rose along with it.

The timing of collective labour agreements also plays a role. Collective agreements that were concluded just before the peak of inflation, or where negotiations took a long time, often only provide compensation for loss of purchasing power later on. As a result, some workers do not benefit from higher wages until further down the road.

Purchasing power: a different experience for everyone

A change in purchasing power is often expressed as a percentage. However, such a percentage does not tell the whole story about how people experience a purchasing power change in their daily lives. For low-income households, a drop in purchasing power of a few percent can have major consequences. They often have little or no financial buffers and must make difficult choices about basic needs such as energy, food or healthcare. High-income households are usually better able to absorb such fluctuations. The figure below shows that poorer households are more likely to use savings to make ends meet and become more dependent on others due to price increases.

The effect of inflation on household assets and debt

High inflation and higher interest rates also affect household wealth. Whether this works out positively or negatively depends, among other things, on the relationship between inflation and interest rates and whether people are able to save or invest.  If inflation exceeds the interest paid on debt, the value of the debt decreases in nominal terms. This benefits people who have more debt than assets.

The impact of inflation on housing costs

Many homeowners actually see their net assets increase. This is largely because their home increases in value while their mortgage debt remains the same. Perhaps more importantly, however, their monthly mortgage payments are often nominally fixed. Most households in the Netherlands fix their mortgage rates for a long time. If wages rise in line with inflation, it becomes easier to cover the monthly mortgage payment or pay off the debt. Tenants, on the other hand, face a rent increase every year, so inflation is often worse for them.

Inflation also affects how much and how you save and invest

Inflation also influences households’ behaviour when it comes to saving. Since the inflation peak, households have been saving more on average as a precautionary measure. However, low-income households have found themselves having to dip into their savings or borrow money more frequently to make ends meet.

Additionally, wealthier households generally also have greater financial assets. This is often spread between different types of investments such as stocks, mutual funds or fixed-value assets like gold. Inflation may affect the value of these investments in various ways. For instance, the value of shares depends on the company's expected future profits, which are partly dependent on inflation. The value of stocks and bonds also depends on future interest rates. When inflation rises, interest rates tend to rise. This reduces their value. Conversely, fixed-value assets such as gold are virtually unaffected by inflation, or even increase in value.

Because different types of financial assets react differently to inflation, holding different types of investments helps protect your assets against inflation. The more assets you have, the easier it is to diversify your wealth among different types of investments. This is why wealthier people tend to be better protected against inflation.

Wealthy people can also spread their assets more easily across multiple countries, giving them better protection against high inflation at the national level. For more information, see this earlier study by the European Central Bank on the effects of inflation on different types of wealth. At DNB, we are also studying these effects.

Pensions also benefit from diversification

Pensions form one of the largest components of households’ total assets. Pension funds jointly invest the pension capital of all members. This means they can also benefit from diversification by holding different types of investments, which helps protect your pension wealth against inflation.